Economic headache awaits Pakistan's next government

KARACHI (Reuters) - Whoever wins Pakistan's upcoming general election can be sure of one thing -- there will be no economic honeymoon.

With annual inflation at its highest in over a decade, the rupee at 6-year lows against the dollar, a hefty trade deficit, pressure from high international oil and food prices and domestic energy shortages, there are pressures on all fronts.

"There are numerous challenges ahead. There are heaps of trouble," said Asad Sayeed, director of private analysis group the Collective for Social Science Research.

"They (the previous government) have left a monumental mess, virtually on every front."

Compounding matters, whoever comes to power in what will mark a long-awaited transition from military to civilian-led rule, will also face the tug of populist expectations of a mainly rural electorate struggling in the face of high food prices.

Consumer prices in January rose 11.86 percent from a year earlier, their highest level in 10-½ years, which analysts attribute to food shortages they say are due to a weaker agricultural crop and government mismanagement.

President Pervez Musharraf's caretaker government blames wheat smuggling to neighboring Afghanistan and hoarding by shopkeepers for the shortfall.

"Inflation is high and it's accelerating, the government's borrowing is out of control," said Sakib Sherani, chief economist for ABN Amro Pakistan.

"The government's interest burden has gone up over the last few months. Its debt servicing burden has gone up, foreign exchange reserves are ... declining," he added. "So all in all, it's actually going to be a fairly challenging scenario for the next government."

GROWTH SLOWDOWN?

The central bank last month revised down its economic growth forecast for 2007/08 (July-June) to 6.6-7.0 percent, citing a weak farm sector that has been one of the engines of growth averaging about 7.0 percent a year since 2002.

Pakistan's trade deficit widened sharply to $2.05 billion in January, double the previous month's gap, which analysts attributed in part to factory shutdowns in the wake of the assassination of opposition leader Benazir Bhutto on December 27.

And is the $160 billion economy facing a slowdown given political instability and macroeconomic worries?

"If not immediately, then certainly over the medium term," Sherani said.

"It may not have an immediate impact, but certainly when people make investment decisions, look out into the next 5-10 years, it'll start at some stage start clouding their investment sentiment as well."

Pakistan's stock market has proved resilient, recovering from sharp losses in the wake of the Bhutto's killing. The bourse is now down 4.55 percent since then, and is only 5.4 percent off life highs hit in October last year.

But investor sentiment among local as well as foreign investors remains brittle.

Foreign investment in the first six months of the fiscal year (July/June) fell 32 percent to $2.17 billion from a year earlier, with foreign portfolio investment down 92 percent, central bank data shows.

Analysts say one key factor will be how the next government deals with calls from ordinary Pakistanis to bring down prices of basic essentials, for many a priority in a land where a quarter of the 160 million population is poor, earning about $16 a month.

The state's bill from subsidizing fuel at the pump to absorb high international prices is alone set to hit about 150 billion rupees ($2.4 billion) for this fiscal year.

"To be honest, I don't care whoever wins the election. What we want is that at least the essentials of life should be easily available at an affordable cost," said Mansoor Khan, a mid-level manager at a pharmaceutical company in Karachi.

"If I have to spend four hours in a queue to get a few kilograms of costly wheat, than I am not too excited even if the GDP growth is 10 percent."

(Editing by Neil Fullick)